RELATIVE  MERIT  OF  PARTNERSHIP  AND  CORPORATE 
ORGANIZATION  UNDER  THE  INCOME  TAX  LAW 

BY 

HENRY  HEATON  BAILY 
A.  M.,  University  of  Illinois,  1921 


THESIS 


Submitted  in  Partial  Fulfillment  of  the  Requirements  for  the 


Degree  of 


MASTER  OF  ARTS 
IN  ECONOMICS 


IN 

THE  GRADUATE  SCHOOL 

OF  THE 

UNIVERSITY  OF  ILLINOIS 


1921 


. 

. 


1 


( 


Digitized  by  the  Internet  Archive 
in  2016 


https://archive.org/details/relativemeritofpOObail 


A study  of  the  comparative  burden  imposed  by  the  Federal  Income 
and  Excess-Profits  Tax  Law  on  the  shareholder  of  a corporation  and 
the  member  of  a partnership  for  the  year  1920, 


CONTENTS 

Pages 

A Introduction,  1 

B The  burden  placed  by  the  income  tax  on  the  member  of 

a partnership.  3 

C The  corporation  income  and  excess-profits  taxes.  9 

D The  burden  imposed  by  the  income  tax  on  the  stockholder 

of  a corporation.  12 

E A comparison  of  the  burden  placed  by  the  income  tax 
on  the  stockholder  in  a corporation  and  the 
shareholder  in  a partnership.  17 


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A.  Introduction. 


The  Revenue  Act  of  1018  furnishes  one  of  the  chief  sources  of  income  for 
the  United  States  Government.  It  nrovides  for  the  taxation  of  the  incomes  of 
individuals  by  a normcCL  tax  and  a graduated  surtax.  It  also  provides  for  the 
taxation  of  the  profits  of  corporations  by  a normal  tax  and  an  excess-profits 
tax;  the  excess-profits  tax  being  based  on  the  relationship  between  the 
invested  capital  and  the  profit.  Thus,  the  tax  levy  on  a corporation  is  made 
in  an  entirely  different  manner  from  that  on  an  individual. 

The  law  does  not  recognize  the  partnership  for  the  purpose  of  taxation. 

Any  profit  of  the  partnership  is  considered  as  a profit  belonging  to  the 
individual  owners  and  as  such  must  be  reported  by  the  individuals  for  taxation, 
regardless  as  to  whether  it  is  distributed  or  not.  This  makes  the  profit  of 
the  partnership  subject  to  the  tax  as  it  is  levied  on  the  income  of  the 
individual. 

Since  we  have  one  method  of  levying  the  income  tax  on  corporations  and 
another  method  of  levying  the  income  tax  on  partnerships  do  they  result  in 
levying  the  same  rate  of  tax  in  every  case?  An  individual  owns  a half  interest 
in  a partnership  which  makes  a profit  of  $10,000  per  year.  Will  the  tax  on  his 
share  of  the  profits  from  the  partnership  be  the  same  as  it  would  be  if  the 
business  were  operated  as  a corporation?  Under  the  present  law  does  the  form 
of  the  business  organization  affect  the  amount  of  the  income  tax?  Other  condi- 
tions being  equal  is  the  burden  imposed  on  the  stockholder  of  a corporation 
the  same  as  that  imposed  on  the  member  of  a partnership?  If  the  form  of  the 
business  organization  affects  the  amount  of  the  income  tax  we  may  expect 
business  men  to  take  cognizance  of  this  in  forming  their  organizations  in  the 
future.  If  in  a particular  case  one  form  of  organization  has  a marked  advantage 
over  the  other  it  may  be  worth  while  for  the  business  man  to  reorganize  his 


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business  so  as  to  take  advantage  of  the  lorn  of  organization  which  pays  but 
a small  income  tax. 


3 


B.  The  burden  placed  by  the  income  tax  on  the  member  of  a partnership. 

Since  the  Income  Tax  Law  does  not  recognize  a partnership  as  a 
distinct  organization,  the  income  of  a partnership  as  such  is  not  taxable, 

A return  must  be  made  setting  forth  the  income  of  the  partnership  and  the 
shares  for  the  division  of  profits.  However,  the  purpose  of  the  return  is 
to  enable  the  tax  commissioners  to  check  the  income  of  the  partnership  with 
the  income  as  reported  by  the  individual.  It  is  in  the  nature  of  a 
supplementary  return.  Each  partner  in  his  own  return  must  show  his  share  of 
the  net  taxable  income  regardless  of  whether  the  income  or  any  part  of  it  has 
been  distributed.  Each  partner  is  taxed  on  his  share  of  the  profits  just  as 
though  the  profit  was  made  by  him  alone  and  not  in  an  association  of 
individuals. 

The  individual  pays  two  taxes,  a normal  tax  and  a surtax.  For  the 
purpose  of  the  normal  tax  certain  credits  are  eillowed  and  then  the  first 
$4,000  of  income  is  taxed  at  the  rate  of  four  percent  and  the  rest  of  the 
income  at  the  rate  of  eight  percent.  The  surtax  is  imposed  on  incomes  of 
over  $5,000.  On  an  income  of  from  $5,000  to  $6,000  the  rate  of  the  surtax 
is  one  percent.  From  $6,000  to  $iCC»000  the  rate  of  the  surtax  increases 
one  percent  with  every  increase  of  $2,000  in  the  income  of  the  individual. 
This  makes  a surtax  rate  of  forty-eight  percent  on  that  portion  of  an 
income  which  is  over  $96,000  and  does  not  exceed  $100,000,  On  that  part  of 
the  income  which  is  over  $100,000  but  does  not  exceed  $150,000  the  rate  of 
the  surtax  is  fifty-two  percent,  while  between  $150,000  and  $200,000  the 
rate  is  fifty- six  percent,  ^ 

A large  number  of  cases  have  been  studied  in  order  to  get  a definite 
idea  of  the  burden  laid  by  the  tax  on  the  individual  who  owns  an  interest  in 

1 — Revenue  Act  of  1918,  Sections  210,  211, 


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a partnership.  Calculations  have  been  made  to  show  the  percent  of  the  net 
profits  the  individual  would  pay  as  income  tax  provided 

(a)  He  owns  either  10f«,  25f„  33  i/3^,  50/.,  66  2/3f«,  75^,,  90%,  or  92,% 

interest  in  the  profits. 

(b)  The  individual  has  an  income  from  other  sources  amounting  to  -0-; 

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$2,0P0;  $5,0C0;  J^0,C00;  $15,CC0;^$35,000;  $50,000;  $75,000  or 

$100,000. 

(c)  The  taxable  income  of  the  partnership  was  $5,000;  $10,000;  $15,000; 

$20,000;  $25,000;  $35,000;  $50,000;  $75,000  or  $100,000. 

(d)  The  personal  exemption  of  the  individual  is  $2,000. 

The  calculations  were  made  for  each  combination  of  share  owned,  the  income  of 
the  individual  from  other  sources,  and  income  of  the  partnership. 

The  method  of  determining  the  tax  paid  by  an  individual  on  the  share  of 
the  income  derived  from  the  partnership,  was  to  find  the  tax  the  individual 
would  pay  if  there  were  no  earnings  from  the  partnership,  and  then  to  find 
the  tax  he  would  pay  if  the  partnership  makes  a given  |?rofit.  The  difference 
between  the  amounts  of  the  taxes  thus  found  can  properly  be  considered  as  the 
tax  paid  on  the  profits  of  the  partnership.  This  difference,  divided  by  the 
individual's  share  of  the  profits,  gives  the  percent  of  the  profits  that  he 
must  pay  to  the  government  as  a tax. 

In  the  case  of  a single  proprietorship  or  partnership  the  full  effect  of 
the  tax  does  not  manifest  itself  until  the  net  income  of  the  individual  is  from 
six  to  eight  thousand  dollars.  The  net  income  as  here  used  signifies  the  net 
income  as  found  according  to  the  law  and  the  regulations.  From  the  net  income 
is  deducted  the  personal  exemption  of  the  individual  and  then  the  normal  tax 
of  eight  percent  applies  only  to  such  part  of  the  net  income  as  is  over  $4,000. 
Furthermore,  the  surtax  affects  only  such  part  of  the  net  income  as  is  over 
$5,000.  If  the  income  of  an  individual  just  begins  to  be  affected  by  the  heavy 
normal  tax  and  the  surtax,  the  percent  of  the  income  taken  by  the  tax  is  small 


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iHien  compared  irlth  the  entire  income.  As  a result  of  this  the  income  of  the 

individual  from  other  sources  must  be  large,  or  the  income  from  the  source  in 

question  must  be  large,  before  the  real  effect  of  the  heavy  surtax  is  felt. 

On  incomes  betireen  $100,000  and  $108,000  the  percent  of  a given  income 

that  is  taken  by  the  tax  increases  at  a greater  rate  than  on  incomes  of  less 

than  $100,000.  Again  when  the  total  income  of  the  individual  reaches  $108,000 

the  percent  taken  by  the  tax  does  not  keep  up  the  same  rate  of  increase  as  it 

does  on  smaller  amounts.  This  is  caused  by  the  fact  that  the  rate  of  the 

surtax  increases  from  forty-eight  percent  to  fifty-two  percent  when  the  net 

income  of  the  individual  is  over  $100,000  and  remains  at  fifty-two  percent 

until  the  net  income  is  $150,000  at  which  point  it  is  increased  to  fifty-six 
2 

percent. 

It  is  worth  while  to  point  out  the  regularity  with  which  the  percent  of 
the  tax  on  a given  income  increases  as  the  other  income  of  the  individual  is 
increased.  If  the  income  tax  takes  twelve  percent  of  the  income  from  a given 
source  when  the  individual  has  other  income  amounting  to  $10,000  it  will  take 
seventeen  percent  of  his  income  from  this  particular  source  if  his  other  income 
amounts  to  $20,000,  and  it  will  take  twenty-two  percent  of  this  income  if  his 
other  income  amounts  to  $30,000.  This  means  an  average  increase  of  one  half 
of  one  percent  in  the  tax  on  the  income  in  question  for  every  increase  of 
$1,000  in  the  other  income  of  the  individual.*  This  rate  of  increase  begins 
when  the  other  income  is  $6,000  and  holds  good  until  the  total  income  is  over 
$100,000.  An  exception  to  this  is  found  when  the  income  from  the  source 

under  consideration  is  small  and  the  change  in  the  other  income  is  not  suffi- 

to 

cient  to  cause  the  income/be  affected  by  a higher  rate  of  surtax, 

2 —  Charts  No,  2 and  3. 

3 —  Charts  No.  1 and  2. 


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Another  point  to  be  considered  is  the  effect  of  the  oimership  of  various 
shares  in  the  partnership.  One  man  secures  ten  percent  and  another  secures 
ninety  percent  of  the  income  of  a partnership.  How  will  the  income  tax  affect 
these  men?  In  this  case  there  are  three  things  to  be  considered:  The  income 

of  the  partnership;  the  share  owned  by  each  individual;  and  the  income 
received  by  the  individual  from  other  sources.  The  two  important  things 
affecting  the  tax  are  first--What  is  the  income  received  by  the  individual 
from  other  sources?  and  second — Is  the  income  from  this  particular  partnership 

4 

large  or  small? 

As  regards  a particular  partnership,  there  is  an  interesting  relationship 
existing  between  the  percent  of  the  taxable  income  that  is  takffli  by  the  tax 
and  the  share  of  the  partnership  that  is  owned  by  the  individual.  The 
following  table  shows  the  percent  of  the  taxable  income  received  from  a given 
partnership  that  will  be  taken  by  the  income  tax.  In  this  table  it  is  consid- 
ered that  in  every  case  the  individual  has  an  income  of  $15,000  from  other 
sources.  The  calculations  made  show  the  results  for  the  man  who  is  entitled 
to  either  25^,  33  l/3/«,  5Cfo,  66  2/3f,,  757«,  90%,  or  9Q%  of  the  taxable 

income  of  the  partnership.  The  percentages  across  the  top  show  the  share  of 
the  partnership  which  the  individual  owns.  The  column  at  the  left  hand  side 
gives  the  various  amounts  of  taxable  income  of  the  partnership  for  irtiich 
calculations  have  been  made.  The  other  columns  show  the  percent  of  his  share 
of  the  profits  which  an  individual  with  other  income  of  $15,C0C  would  pay  as 
an  income  tax.  The  last  column  at  the  right  shows  the  average  increase  for 

each  additional  percent  of  profits  claimed  by  the  individual.  The  rate  of 
for  each  additional  percent  owned 

increase/becoraes  more  exact  as  the  amount  of  the  income  of  the  partnership 
increases. 


4 — onart  no.  45 


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7 


Other  Income  oi  tiie  Individual  — i^l5,000. 


Income 

of  the 

company 

10% 

Zi% 

0 

s 

CO 

14. 

14. 

10,000 

14. 

14.60 

15,000 

14.33 

14.93 

20,000 

14.50 

15.20 

25,000 

14.60 

15.56 

35,000 

14.86 

16.17 

50,000 

15.20 

17.08 

75,000 

15.86 

18.68 

100,000 

16.50 

20.24 

Share  Owned 


33  % 

50% 

66  % 

75% 

14.40 

14.60 

14.80 

14.93 

14.80 

15.20 

15 . 65 

15.85 

15.20 

15.86 

16.50 

16.80 

15.65 

16.50 

17.35 

17.73 

16.08 

17.08 

18.16 

18.68 

16.91 

18.37 

19  .el 

20.56 

18.16 

20.24 

22.32 

23.37 

20.24 

23.37 

26.50 

28.06 

22.32 

26.50 

30.67 

32.75 

Average 


90'% 

98% 

increase  lor 
each 

additional 
percent  owned 

15.11 

15.18 

.01%'#'  ) 

16.22 

16.45 

.02  Vw"' 

17.37 

17 . 67 

jimate 
.04%  ; 

18.50 

18.69 

.04  f%— .05^f: 

19.58 

20.12 

.06%— .06  ^% 

21.87 

22.55 

.08  2/3% 

25.24 

26.24 

.12  1/2% 

30.87 

32.37 

.18  4/5% 

36.63 

38.53 

.25% 

In  studying  the  table  it  is  interesting  to  notice  that  for  any  given  income 
of  the  partnership,  the  percent  of  income  paid  as  a tax  by  individuals  owning 
different  percents  of  tae  partnership,  will  vary  in  proportion  to  the  share 
owned.  This  variation  becomes  more  exact  As  the  profits  i,of  the  ..partner  ship 
increase,  provided  that  the  total  income  of  the  individual  is  not  over  $100,000 
and  thus  become  affectea  by  trte  change  in  the  rate  of  the  surtax  mentioned 
heretofore.  For  instance  the  partnership  has  a taxable  income  of  $100,000. 

The  individual  who  secures  ten  percent  of  the  profit  will  pay  16.50fo  of  this 
income  to  the  government  as  a tax.  The  individual  who  secures  twenty- five 
percent  of  the  profit  will  pay  20.24/-  of  this  income  as  a tax.  The  difference 
between  the  ten  percent  owned  and  the  twenty- five  percent  owned  or  fifteen 
percent  results  in  a difference  of  3.v4%  in  the  tax.  This  makes  an  increase 
of  .25/9  in  the  tax  for  every  increase  of  one  percent  in  the  ownership.  A 
study  of  the  figures  shows  that  this  same  rate  of  increase,  ,25^  for  each  one 


r ■ , 


8 


percent  of  additional  oimership,  holds  good  until  the  individual's  total 
income  from  all  sources  is  $100,000.  Again,  if  the  partnership  has  a taxable 
income  of  $25,000  the  increased  tax  for  each  one  percent  of  additional 
omiership  is  from  .Oefo  to  .065^.  It  should  also  be  noticed  that  the  starting 
point  for  this  table  is  fourteen  percent,  this  percent  being  made  up  of  a 
normal  tax  of  eight  percent  and  a surtax  of  six  percent. 

The  figures  in  the  table  given  show  the  tax  when  the  income  from  other 
sources  is  $15,000.  If  the  other  income  is  changed  the  average  increase  for 
each  additional  one  percent  owned  remains  the  same.  Two  exceptions  should 
be  made  to  this  statement.  First:  It  does  not  hold  true  when  the  individual 

has  a personal  exemption  of  $2,000  and  the  other  income  is  less  than  $6,C00. 
Second:  It  will  not  hold  true  if  the  total  income  is  over  $100,000, 


* * I 

I A - 4 


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9 


C.  The  Corporation  Income  and  Excess-Profits  raxes. 

In  the  case  of  a corporation  two  distinct  taxes  are  levied.  First,  tne 

normal  income  tax  oi  ten  pei  cent  on  aix  taxaole  inco^ae  alter  tne  excess-profits 

b 

tax  and  tne  exemption  or  |2,0C0  have  been  deducted.  Second,  the  excess- 
profits  tax.  ^ The  excess-profits  tax  is  based  on  the  proportion  of  the 
taxable  profit  to  the  invested  capital.  Before  calculating  the  excess-proiits 
tax  the  corporation  is  allowed  an  exemption  of  eight  percent  of  its  invested 
capital  plus  $3,000.  This  exemption  is  known  as  the  excess-profits  credit. 

The  excess-profits  tax  is  found  by  two  distinct  calculations:  First,  the 

taxable  income  that  is  not  over  twenty  percent  of  the  invested  capital,  minus 
the  excess-profits  credit,  is  taxed  at  the  rate  of  twenty  percent.  Second; 
all  income  over  twenty  percent  of  the  invested  capital,  minus  any  of  the 
excess-profits  credit  that  could  not  be  used  in  the  first  case  is  taxed  at 
the  rate  of  forty  percent,  ihe  sum  of  the  two  amounts  thus  found  constitute 
the  excess-profits  tax, as  found  for  the  calender  year  1919. 

As  a result  of  the  above  provisions  if  the  corporation  has  a small 


5 —  Revenue  Act  or  1918.  Section  230.  (aj  inat there  should  be  levied 

collected,  and  paid  for  each  taxable  year  upon  tne  net  income  of  every 
corporation  a tax  at  the  following  rates; 

(l)  For  the  calender  year  1916,  12  per  centum  of  the  amount  of  the  net 
income  in  excess  of  the  credits  provided  in  section  23o;  and 

{Z)  For  each  calender  year  thereafter,  10  per  centum  of  such  excess  amount 

6 —  Revenue  Act  of  1918.  Section  301.  (bj  For  the  taxable  year  1919  and  each 

taxable  year  thereafter  there  shall  be  levied,  collected,  and  paid  upon 
the  net  income  of  every  corporation  (except  corporations  taxable  under 
subdivision  (c)  of  this  section)  a tax  equal  to  the  sum  of  the  following; 

20  per  centum  of  the  amount  of  the  net  income  in  excess  of  the 
excess-profits  credit  (determined  under  section  312 j and  not  in  excess  or 
20  per  centum  of  the  invested  capital; 

40  per  centum  oi  the  amount  of  the  net  income  in  excess  of  2C  per 
centum  of  the  invested  capital. 


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i'-''«  n?  b«tt,tV6itq[  siXiv'-nr*  u/l.^  'V,ii,»»- 

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©riJ  to  rJ  fliSi  'xo  'ftn,^'  lo  oxititfia  . 

;«*  daaaxa  >u  raxx  umi*  txothatt*  y^tfrtfj  ■rhxr-U 


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‘ •!’  ’■I'jri'lPJ 


10 


invested  capital  tne  excess-profits  credit  will  not  afford  much  relief  oeiore 

the  excess-profits  tax  oi  lorty  percent  uegius  to  taite  effect.  To  afiora  tne 

necessary  reiiei  anotiier  method  of  computing  tiie  excess-profits  tax  was  mahe,  ^ 

It  is  to  the  effect  that  on  a taxable  income  of  over  |3,0C0  and  less  than 

$20,000  a corporation  should  pay  a tax  of  not  more  than  twenty  percent  of  this 

not  more  than 

income  and  that  on  all  taxable  income  over  $20,000  it  should  pay/forty  percent 

of  the  income  as  a tax.  This  method  has  no  reference  to  the  invested  capital 

and  any  corporation  is  given  the  privilege  of  using  either  this  method  or  the 

method  given  in  the  proceeding  paragraph,  whichever  imposes  the  least  tax. 

The  calculations  for  the  corporation  tax  have  been  made  for  corporations 

with  an  invested  capital  of  $10,CC0;  $15,000;  $20,000;  $25,000;  $35,000;  $50,000 

$75,000;  $100,000;  $150,000,  and$20C,000.  For  each  different  amount  of  invested 

capital  calculations  have  been  made  to  find  the  tax  the  corporation  would  pay 

on  an  income  of  $5,000;  $10,000;  $15,000;  $20,000;  $25,000;  $35,000;  $50,000; 

B 

$75,000,  and  $100  OCO. 

A study  of  chart  No.  4 shows  that  the  tax  paid  by  the  corporations  with 
an  invested  capital  of  $25,000  and  $35,000  is  the  same  in  every  case  given. 

(This  will  also  hold  true  for  any  corporations  having  an  invested  capital  that 
is  between  these  two  figures.)  If  the  invested  capital  is  $20,000,  $15,000, 
or  $10,000  the  only  change  in  the  tax  is  when  the  profit  is  $5,000;  the  tax 
increasing  as  the  invested  capital  decreases.  If  the  invested  capital  of  the 
corporation  is  $50,000  it  will  pay  a different  amount  of  tax  when  the  profit 

V — Revenue  Act  of  1918,  Section  302.  the  tax  imposed  by  subdivision 

(b)  of  section  301  shall  in  no  case  be  more  than  20  per  centum  of  the  amount 

of  the  net  income  in  excess  of  $3,000  and  not  in  excess  of  $20,000,  plus 

40  per  centum  of  the  amount  of  the  net  income  in  excess  of  $20,000. 

8 — See  charts  No.  4 and  5 for  the  percent  of  the  taxable  income  of  the 

corporation  that  is  taken  by  the  corporation  income  and  excess-profits 
taxes. 


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11 


is  $10,000.  In  all  other  cases  studied  it  idll  pay  the  same  tax  as  the 
corporation  irith  an  invested  capital  of  $25,000.  This  similarity  in  the  tax 
is  caused  by  the  method  of  calculating  the  excess-profits  tax  which  is  given 
in  Section  302  of  the  Revenue  Act  of  1918. 

Under  this  section  the  income  tax  cannot  be  more  than  twenty  percent  of 
the  profits  between  $3,000  and  $20,000.  This  means  that  a corporation  will  use 
Section  301  in  calculating  its  excess-profits  tax  if  its  excess-profits  credit 
is  sufficient  to  reduce  the  tax  on  its  profits  between  $3,000  and  $20,000  to 
less  than  twenty  percent  of  the  profit.  As  the  profit  increases  the  corporation 
will  find  relief  by  using  Section  302.  As  the  invested  capital  increases  the 
corporation  will  find  Section  301  more  to  its  advantage.  If  the  profit  is 
over  $20,000  and  the  invested  capital  is  less  than  $71,428.48  the  corporation 
should  always  use  the  method  given  under  Section  302,  When  the  invested  capital 
is  from  $71,428.48  to  $71,428.67  it  makes  no  difference  which  method  is  used. 
When  the  invested  capital  amounts  to  $71,428,68, or  more,  the  corporation  should 
always  use  the  method  given  under  Section  301.  It  should  also  be  remembered 
that  in  every  case  where  the  method  given  under  Section  302  is  used  the  tax  on 
a given  income  is  the  same  regardless  of  the  amount  of  the  invested  capital. 

Attention  is  also  called  to  the  fact  that  as  the  invested  capital  of  the 
corporation  reaches  $100,000,  $150,000  or  $200,000  on  a small  taxable  profit 
the  rate  of  the  tax  will  be  the  same  regardless  of  the  amount  of  invested 
capital.  This  is  true  so  long  as  their  excess-profits  credit  is  larger  than 
their  profit  and  as  a result  they  are  subject  to  the  normal  tax  only. 


*»  * > *1 


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12 


D.  The  burden  Imposed  by  the  income  tax  on  the  stockholder  in  a corporation. 

While  we  speak  of  the  excess-profits  tax  and  the  corporation  income  tax 

as  being  taxes  on  the  income  of  the  corporation,  yet  they  are  really  borne 

by  the  individual  stockholders.  The  profits  remaining  for  distribution  are 

decreased.  The  tax  takes  profits  which  could  otherwise  be  distributed  as 

dividends  or  if  left  in  the  corporation  would  enhance  the  value  of  each  share 

of  stock.  Thus,  each  stockholder  csui  claim  that  his  share  of  the  tax  bears  the 

same  proportion  to  the  total  tax  as  the  number  of  shares  of  stock  he  owns  bears 

to  the  total  number  of  shares  of  the  outstanding  stock.  This  means  that  when 

we  consider  the  burden  that  the  income  tax  places  on  the  individual  stockholder 

of  a corporation  we  must  consider  not  only  the  surtax  which  he  pays  on  dividends 

but  also  the  corporation  income  and  excess-profits  taxes,  (Dividends  are  not 
subject  to  the  nomal  tax.} 

The  following  points  must  be  considered  when  discussing  the  above  problem: 

(a)  The  invested  capital  of  the  corporation. 

(b)  The  taxable  income  of  the  corporation, 

(c)  The  dividends  declared  by  the  corporation  from  the  profit  remaining 

after  the  corporation  income  and  excess-profits^ are  paid. 

(d)  The  proportion  which  the  shares  owned  by  the  individual  bears  xu 

the  witire  capited  stock  outstanding.  This  will  be  referred 
to  as  "share  owned", 

(e}  The  amount  of  income  received  by  the  individual  from  other  sources, 

(f)  The  personal  exemption  of  the  stockholder. 

Here  again  when  considering  the  portion  of  the  dividends  that  is  taken 
by  the  tax  one  should  find  the  amount  of  tax  that  the  individual  pays  on  his 
entire  income.  From  this  amount  deduct  the  tax  he  would  pay  if  no  dividends 
are  declared  by  the  corporation  in  question.  This  gives  the  amount  of  tax  the 
individual  pays  as  a result  of  the  dividends.  The  tax  paid  on  dividends  added 


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13 


to  his  share  of  the  tax  paid  by  the  corporation  will  give  the  total  tax  that 
he  may  claim  as  levied  against  his  portion  of  the  income  of  the  corporation. 

If  the  corporation  does  not  pay  a dividend  the  individual's  share  of 

the  tax  paid  by  the  corporation  will  be  the  only  tax  that  is  levied  against 

his  share  of  the  income  of  the  corporation.  Consequently  in  this  case  the 

rate  of  the  tax  levied  against  the  stockholders  is  the  same  regardless  of 

both  the  share  owned  and  their  income  derived  from  other  sources. 

following  page  24 

A careful  study  of  thejifi  charts/ shows  the  following: 

9 

First:  Changes  caused  by  the  invested  capital  of  the  corporation. 

(a)  As  the  invested  capital  increases  the  percent  of  the  profits  taken 

by  the  tax  decreases.  This  is  principally  caused  by  the  increase 
in  the  excess-profits  credit.  The  following  illustrates  this 
point.  For  the  cases  studied  the  tax  on  a corporation  with  an 
invested  capital  of  either  $10,000,  $15,000  or  $20,000  is  the  same 
as  the  tax  on  a corporation  with  an  invested  capital  of  either 
$25,000  or  $35,000  except  when  the  profit  is  $5,000,  the  tax  is 
increased  as  the  invested  capital  is  decreased.  Also  if  the 
invested  capital  is  $50,000  the  only  change  in  the  results  is  when 
the  profit  is  $10,000,  the  tax  being  smaller  for  a corporation 
of  this  size, 

(b)  The  greatest  change  is  found  when  the  taxable  profit  is  between 

$5,000  and  $50,000.  The  excess-profits  credit  bein^greater  for 
the  large  corporation  than  for  the  small  corporation  there  is  not 
the  same  rapid  increase  in  the  tax  when  the  corporation  has  but 
a small  income. 

9 — See  charts  ITo.  8 and  9. 

10  — See  charts  No.  6,  8,  10  and  11. 


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14 


Second:  Changes  caused  by  the  dividends  declared  by  the  corporation  from  the 

profit  remaining  after  the  corporation  income  and  excess-profits 
taxes  eu*e  paid. 

(a)  If  no  dividend  is  declared  the  corporation  income  and  excess-profits 

12 

taxes  constitute  the  entire  tax  on  this  income. 

(b)  A dividend  of  twenty-five  percent  of  the  profits  will  have  the  effect 

the  individual's  proportion  of 

of  increasing/the  tax  already  paid  by  the  corporation  by  about 
two  percent  for  every  $25,000  income  the  individual  has  from 
other  sources. 

(c)  A dividend  of  one  hundred  percent  of  the  profits  will  have  the  effect 

the  individual's  proportion  of 

of  increasing/ the  tax  already  paid  by  the  corporation  by  about 
eight  percent  for  every  $25,000  income  the  individual  has  from 
other  sources. 

Third:  Changes  caused  by  difference  in  shares  owned. 

(a)  If  no  dividend  is  declared  the  tax  paid  by  the  corporation  falls 

with  equal  weight  on  all  stockholders  regardless  of  both  the 

13 

amount  of  stock  owned  and  their  income  from  other  sources. 

(b)  If  the  dividend  is  twenty-five  percent  of  the  profits  remaining 

after  the  corporation  income  and  excess-profits  taxes  are  paid: 

(1)  If  the  corporation  has  an  invested  capital  of  from  $10,000 
to  $35,000  the  percent  of  the  individual's  share  of  the 
income  of  the  corporation  that  is  taken  by  the  tax  will  be 
practically  the  same  whether  ho  owns  a small  share  or  a 


11— -See  charts  No.  10,11,  12,  13. 

12 —  See  chart  No.  14. 

13 —  See  chart  No.  14. 


14— See  charts  No.  10,  11,12  and  13 


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15 


large  share  in  the  corporation.  For  the  man  who  owns  ten 
percent  of  the  stock  and  the  man  who  owns  ninety  percent 
' of  the  stock  the  variation  is  from  nothing  to  six  tenth 

of  one  percent  (.6^),  This  variation  is  caused  by  the 
profit  of  the  corporation.  If  the  profit  of  the  corporation 
is  $5,000  the  variation  will  run  from  nothing  to  ,C2fo;  if 
the  profit  is  $25,000  the  variation  will  run  about  ,18^; 
if  the  profit  is  $100,000  the  variation  will  run  from  .45'fo 
to  9 ^ Jo  m 

(2)  If  the  corporation  has  an  invested  capital  of  $100,000  the 
variation  is  just  about  the  same  as  is  given  above,  the 
difference  is  usually  less  than  one  tenth  of  one  percent, 

(c)  If  the  dividend  is  one  hundred  percent  of  the  profits  remaining 
after  the  corporation  income  and  excess-profits  taxes  are 
deducted: 

11)  If  the  corporation  has  an  invested  capital  of  from  $10,000 
to  $35,000  the  variation  in  the  percent  of  the  income 
taken  by  the  tax  for  the  man  who  owns  ten  percent  and  the 
man  who  owns  ninety  percent  is  from  one  percent  to  seven 
and  one  hol^  percent.  The  variation  is  caused  by  the 
profit  of  the  corporation  and  not  by  the  other  income  of 
the  individual.  If  the  profit  of  the  corporation  is  $5,000 
the  variation  is  from  one  percent  to  one  and  three  tenths 
percent;  if  the  profit  is  $25,000  the  variation  is  about 
two  and  three  fourth  percent;  if  the  profit  is  $100,000  the 
variation  is  about  seven  and  one  half  percent, 

15 --See  charts  No,  6 and  7, 


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16 


(2)  If  the  corporation  has  an  invested  capital  of  $100,000  the 

variation  is  again  about  the  same  as  is  given  above,  althougl 
it  may  differ  at  times  to  about  one  third  of  one  percent. 

The  variations  given  in  (b)  and  (c)  above  hold  true  regardless  of 
whether  the  stockho Lders  have  an  income  of  $15,000  or  $75,000  from  other 
sources.  Two  exceptions  should  be  noted  to  this:  First,  before  these 

variations  hold  true  the  individual ' s income  from  other  sources  must  be 
subject  to  both  the  normal  tax  of  eight  percent  and  the  surtax.  Secona, 
if  the  income  of  the  individual  from  other  sources  amounts  to  $100,000 
and  the  total  income  of  the  stockholders  does  not  exceed  $150,000  the 
tax  will  take  the  same  percent  of  the  income  of  the  stockholder  regardless 
as  to  whether  they  own  ten  percent,  fifty  percent  or  ninety-eight  percent 

of  the  stock  of  the  corporation.  Third,  if  the  other  income  is  less  than 
$100,000  but  the  total  income  is  over  $100,000  the  amount  of  the  variation 
between  the  burden  placed  by  the  taxes  on  the  different  stockholders  is 
decreased,  the  amount  of  the  decrease  depending  on  how  near  the  other 
income  is  to  $100,000  and  the  share  of  the  dividend  going  to  each 
stockholder. 


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17 


E.  A comparison  of  the  burden  placed  by  the  income  tax  on  the  stockholder  in 

a corporation  and  the  shareholder  in  a partnership. 

If  the  income  of  an  individual  from  other  sources  is  ?2,000  or  less,  it  is 

much  better  for  him  to  conduct  his  business  in  the  form  of  a single  proprietor- 

1-6 

ship,  or  as  a partnership  than  as  a corporation.  The  only  exception  to  this 
is  in  the  case  of  the  individual  who  owns  practically  all  the  stock  of  the 
corporation,  the  invested  capital  of  the  corporation  amounts  to  over  $100,000, 
and  the  taxable  profits  are  over  $10, 000.  Even  in  this  case  it  would  be 
necessary  to  increase  the  invested  capital  very  rapidly  or  an  increase  in  the 
profits  will  give  the  advantage  to  the  partnership  form  of  organization.  Again, 
if  a man  has  an  income  of  $25,000  from  other  sources,  and  his  share  of  the 

profits  of  the  business  is  ten  percent  it  is  best  for  him  to  operate  as  a 

partnership  if  the  income  of  the  business  approaches  vl5,000.  This  is  not  true 
for  an  invested  capital  of  $150,000  or  more  unless  the  profits  amount  to 
some  $40,000.  The  above  holds  true  when  no  dividends  are  paid.  If  dividends 
are  paid  the  advantages  of  operating  as  a partnership  are  still  more  evident. 

On  the  other  hand,  if  the  individual  has  an  income  of  $50,000  from  other 
sources  he  should  always  operate  the  business  as  a corporation  if  he  owns  more 
than  a half  interest  in  it.  Even  if  he  only  owns  ten  percent  of  the  business 
he  should  always  operate  as  a corporation  if  the  income  of  the  business  is  not 

over  $30,000.  Again,  if  he  has  an  income  of  $25,000  from  other  sources  he  should 

operate  the  business  as  a corporation  i^e  owns  an  interest  of  ninety-oight 
percent  and  the  profit  of  the  business  is  not  over  $15,000.  It  is  worth  noticing 
that  as  the  invested  capital  of  the  business  increases  the  corporate  form  of 
organization  becomes  more  and  more  advantageous.  The  payment  of  dividends  by 
the  corporation  makes  the  corporate  organization  less  desirable. 


16--See  chart  No.  14. 


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18 


It  is  difficult  to  give,  even  approximately,  any  general  statement 
concerning  the  comparative  advantages  of  corporate  and  partnership  organizations 
As  has  been  seen  there  are  several  conditions  affecting  the  results  any  one  of 
which  may  be  sufficient  to  throw  the  advantage  to  one  organization  as  against 
the  other.  However,  the  following  data  give  the  general  tendency  of  the  effect 
of  the  more  important  items  which  must  be  considered.  The  results  are  stated 
for  the  various  conditions  which  were  considered, 

(a)  The  income  of  the  individual  from  other  sources. 

As  the  income  of  the  individual  from  other  sources  increases  the 
corporate  organization  becomes  more  advantageous  provided  the  payment  of 
dividends  does  not  affect  the  result  the  other  way.  If  he  has  no  income  from 
other  sources  he  should  always  operate  as  a partnership  regardless  of  the 
share  owned.  The  same  is  practically  always  true  if  the  other  income  is  $2,C00, 
When  the  other  income  is  $5,000,  $1C»000,  $15,000,  or  $25,000  the  result  will 
in  each  case  be  largely  determined  by  the  capital  invested  in  the  business, 
the  income  of  the  business,  the  share  owned,  and  the  dividends  paid.  If  the 
other  income  is  $35,000  the  advantage  on  a small  profit  is  with  the  corporation 
but  as  the  profit  increases  it  may  be  thrown  either  way  according  to  the  other 
influences.  If  the  other  Income  is  $50,000  the  corporate  organization  has  a 
still  greater  advantage.  If  the  other  income  is  $75,000  or  more  the  advantage  ±i 
always  with  the  corporation  unless  it  is  changed  as  the  result  of  the  payment 
of  dividends, 

(b)  The  effect  of  the  invested  capital, 

As  the  amount  of  capital  invested  in  the  business  is  increased  it  causes 
a reduction  in  the  tax  paid  by  the  corporation,  but  will  have  no  effect  on 

17--See  charts  No.  8 and  9. 


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the  tax  paid  by  a partner  on  the  income  of  a partnership.  An  increase  in  the 
invested  capital  from  $10,000  to  $20,000  or  even  to  $35,000  will  not  affect  the 
tax  on  a profit  of  $10,000  or  more.  It  does,  however,  have  the  effect  of 
reducing  the  tax  on  an  income  of  $5,000,  The  lowest  possible  tax  rate  on  a 
corporation  profit  of  ;f5,C00  is  six  percent,  provided  the  conditions  studied 
are  assumed.  The  invested  capital  of  a corporation  must  be  increased  to  over 
$71,428,67  before  there  will  be  any  effect  on  the  tax  rate  if  the  profit  of 
the  business  is  over  $20,000.  As  the  invested  capital  increases  the  relief 
is  first  felt  on  the  smaller  profits  and  the  tendency  is  to  make  the  increase 
in  the  tax  rate  more  gradual.  This  is  caused  by  the  increase  in  the  excess- 
profits  credit  which  in  turn  results  in  a smaller  excess-profits  tax, 

(c)  The  effect  of  the  taxable  profit  of  the  business. 

As  the  taxable  profit  increases  the  effect  of  the  increase  is  to  cause  a 
larger  percent  of  the  profit  to  be  paid  as  an  income  tax.  If  an  individual 
is  entitled  to  but  a small  share  of  the  profits  of  a partnership  an  increase 
in  the  profits  may  cause  but  a small  increase  in  the  tax  on  his  income.  He 
must  obtain  a good  share  of  the  profits  from  the  business  under  consideration 
before  an  increase  in  th^rofits  of  the  partnership  causes  a decided  increase 
in  his  income  tax.  If  the  invested  capital  in  a corporation  is  small  there  is 
a rapid  increase  in  the  tax  on  the  profits  until  they  reach  some  $50,000  but 
after  this  the  increase  is  moderate.  If  the  invested  capital  o^he  corporation /s 


$150, OOo  ot  $200,000  the  increase  in  the  tax  on  the  first  $15,000  or  $20,000 
of  the  profit  is  small  but  after  this  point  is  reached  the  increase  is  fairly 
regular  on  a profit  up  to  $100,000. 


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20 


(d)  The  effect  of  the  share  of  the^usiness  oirned  by  the  individual, 

(1)  In  a partnership  an  increase  in  the  share  owned  causes  an  increase  in  the 

Id  /t/9' 

tax  on  a partner.  The  rate  of  the  in crease^yf airly  regular  until  the 
total  income  of  the  partner  is  over  $100,000. 

(2)  In  a corporation  the  difference  in  the  number  of  shares  owned  does  not 

affect  the  tax  on  the  individual  if  dividends  are  not  declared.  On 
dividends  the  individual  is  subject  to  the  surtax  when  his  income 
from  other  sources  is  $5,000  or  on  that  part  of  the  income  from  the 
dividends  which  makes  a total  income  of  over  $5,000,  This  causes  an 
increase  in  his  tax.  The  larger  the  share  owned  the  sooner  will  the 
corporate  organization  become  the  more  desirable  if  no  dividends 
are^^aid, 

(e)  The  effect  of  dividends  declared  by  the  corporation. 

If  twenty-five  percent  of  the  profits  remaining  after  the  tax  is  paid  are 
declared  as  dividends  the  effect  is  to  increase  the  taxes  paid  by  the  individual 
(result  of  the  surtax  on  the  dividends)  and  will  thus  make  the  partnership  more 
desirable  than  the  corporation.  If  all  the  net  profits  are  declared  as  dividends 
the  effect  is  to  increase  the  tax  on  the  individual  to  a point  where  it  is 
better  for  him  to  operate  the  business  as  a partnership  in  practically  every 
case.  The  only  exceptions  to  this  are  when  the  taxable  profit  is  $5,000  on  an 
invested  capital  of  $25,000  or  $35,000;  and  when  the  profit  is  less  than  $20,000 

A 20 

on  an  invested  capital  of  $100,000. 

To  restate  the  above  exceptions  more  definitely: 

First:  If  the  invested  capital  of  a corporation  is  less  than  $35,000  and  all 

13--See  chart  No.  3 and  table  on  page  7, 

19—  See  charts  No.  10,  11,  12,  13,  and  14. 

20—  See  charts  No.  10,  11,  12,  and  13. 


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21 


the  earnings  remaining  after  the  corporation  income  and  excess-profits  taxes 
are  paid  are  declared  as  dividends  it  would  always  be  to  the  interest  of  all 
of  the  stockholders  to  operate  as  a partnership  when  the  taxable  profit  is 
$10,000  or  more. 

Second;  If  the  invested  capital  is  $100,000  and  the  other  conditions  remain 
as  given  above  it  would  always  be  to  the  interest  of  all  of  the  stockholders 
to  operate  as  a partnership  when  the  taxable  profit  is  $20,000  or  more.  Also, 
if  the  taxable  profit  is  ipl5,000,  for  all  the  stockholders  who  have  an  income 
from  other  sources  of  $75,000  or  less  it  will  be  to  their  interest  to  operate 
as  a partnership. 

Anyone  who  studies  the  charts  will  be  impressed  by  the  inequalities  in 
the  levying  of  the  tax,  caused  by  the  different  methods  of  assessing  the 

income  of  a single  proprietorship  or  partnership  on  the  one  hand  and  a 

corporation  on  the  other.  For  example,  let  us  consider  two  men  A and  B. 

Each  has  an  income  of  $2,000  from  other  sources  besides  the  company  in 

question  and  each  has  a personal  exemption  of  $2,000,  A secures  ten  percent 
of  the  profits  of  a partnership  while  B owns  ten  percent  of  the  stock  of  a 
corporation,  both  companies  have  a taxable  profit  of  $25,000.  A will  pay 
four  percent  of  his  share  of  the  income  of  the  partnership  to  the  government 
as  an  income  tax.  If  the  invested  capital  of  the  corporation  in  which  B is 
interested  is  less  than  $71,428,67  the  income  tax  will  take  28, 64^0  of  his 
share  of  the  income  of  the  company.  Thus  the  tax  on  B is  over  seven  times  as 
heavy  as  that  on  A.  In  this  case  the  tax  on  B is  the  same  whether  dividends 
are  paid  or  not. 

Let  us  vary  the  example  by  assuming  that  each  owns  ninety-eight  percent 
of  the  company  instead  of  ten  percent.  A will  pay  thirteen  percent  of  the 
income  of  the  partnership  to  the  government  while  from  B the  government  will 


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take  28.64‘/o  of  iiis  share  of  the  profits  even  though  no  dividends  have  been 
declared.  If  all  the  net  earnings  remaining  after  the  payment  of  the  tax  are 
declared  as  dividends  the  tax  on  B's  share  of  the  profits  will  be  a total  of 
31*37%  of  his  share  of  the  earnings.  Thus  the  tax  on  B is  over  two  times  as 
much  as  it  is  on  A.  In  both  of  these  cases  the  advantage  is  with  the  partner- 
ship form  of  organixation. 

Let  us  consider  another  case.  X and  Y each  has  an  income  from  sundry 
sources  amounting  to  $100,000  and  each  is  entitled  to  a personal  exemption  of 
$2,000,  X has  a ten  percent  Interest  in  a partnership  and  Y owns  ten  percent 
of  the  stock  of  a corporation  with  an  invested  capital  of  $25,000  or  more. 

In  each  case  the  company  has  a taxable  profit  of  $5,000.  X will  pay  sixty 
percent  of  his  share  of  the  profits  of  the  partnership  to  the  goveimment  as 
an  income  tax.  If  no  dividends  are  declared  by  the  corporation  Y can  only 
claim  that  six  percent  of  his  share  of  the  profit  of  the  corporation  is  taken 
by  the  tax.  In  this  case  the  tax  on  the  owner  of  the  partnership  is  ten  times 
as  heavy  as  the  tax  on  the  owner  of  the  corporation. 

If  we  vary  this  last  case  and  assume  that  the  individuals  each  own, 
ninety-eight  percent  of  the  company  the  result  will  be  the  same  if  no  dividends 
are  declared  by  the  corporation.  If,  however,  in  the  last  case  the  corporation 
declares  as  dividends  all  of  its  net  earnings  remaining  after  the  taxes  are 
paid  Y will  be  able  to  claim  that  54,88%  of  his  share  of  the  profits  go  to 
the  government  as  taxes  whether  he  owns  ten  percent  or  ninety-eight  percent 
of  the  stock  of  the  company.  This  brings  their  taxes  within  about  five  percent 
of  each  other  but  the  advantage  still  rests  with  the  corporate  form  of 
organization. 

These  illustrations  based  upon  the  same  conditions,  only  the  form  of  the 
business  organization  being  different,  show  in  one  case  that  the  tax  borne  by 


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23 


the  stockholder  of  tne  corporation  is  more  than  seven  times  that  which  is 
borne  by  the  owiers  of  a partnership.  In  another  case  the  tax  borne  by  the 

owier  of  a partnership  is  ten  times  that  which  is  borne  by  the  stockholder  of 

a corporation.  While  the  cases  selected  show  a wide  range  of  variation  yet 
cases  showing  greater  variations  could  be  selected.  It  would  also  be  possible 
to  state  cases  where  the  result  would  be  practically  the  same,  yet  it  would 
be  more  difficult  and  would  require  greater  care  in  selection.  The  great 
majority  of  cases  have  a variation  of  from  ten  to  fifteen  or  twenty  percent. 

It  should  also  be  remembered  that  the  tax  on  a single  proprietorship  is 

levied  in  the  same  way  as  a tax  on  a partnership.  In  the  case  of  a single 
proprietorship  the  entire  tax  is  borne  by  one  owner,  and  this  means  that  his 
tax  will  be  a little  larger  than  the  tax  on  the  individual  who  is  entitled 
to  ninety-eight  percent  of  the  profits  of  a partnership.  Thus  the  same 
inequality  that  has  been  found  to  exist  between  the  taxes  on  a partnership 
and  a corporation  will  also  exist  between  a single  proprietorship  and  a 
corporation. 

We  may  summarize  the  principal  points  into  the  following  general  facts: 
First:  As  a result  of  the  method  of  levying  income  taxes  by  the  Revenue  Act 

of  1918  the  percent  of  the  profits  of  a given  business  that  is  taken  by  the 
various  income  taxes  is  affected  by  the  form  of  the  business  organization. 
Second:  While  the  burden  of  the  tax  on  the  partner  and  the  stockholder  may 
be  the  same  it  will  usually  be  heavier  in  one  case  than  in  the  other;  in  one 
case  it  will  be  heavier  on  the  partner  and  in  another  case  it  will  be  heavier 
on  the  stockholder. 

Third:  The  variation  is  caused  by  the  following: 

A difference  in  the  method  of  levying  the  tax. 

(a) /(The  income  tax  is  levied  by  one  method  on  the  members  of  a 

partnership  and  by  another  method  on  the  stockholders  of  a 

corporation, ) 


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24 

(b)  The  amount  of  capital  invested  in  the  business, 

(c)  The  taxable  profit  of  the  company, 

(d)  The  part  of  the  profits  remaining  after  the  corporation  income  and 

excess-profits  taxes  are  paid  that  are  declared  as  dividends  b^y 
the  corporation, 

(e)  The  share  owned  by  the  individual. 

(f)  The  amount  of  income  received  by  the  individual  from  other  sources. 

(g)  The  personal  exemption  of  the  individual. 


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Chart  No . 1 


Business  Organization — Partnership 

Chart  showing  the  percent  of  the  income  received 
by  a partner  from  a given  partnership  that  is  taken 
by  the  normal  tax  and  surtax: 

Provided: 

(a)  The  partner  is  entitled  to  ten  percent  of  the 

profits  of  the  partnership. 

(b)  The  income  of  the  individual  from  other  sources 

is  the  amount  indicated  at  the  right  end  of 
each  line, 

(c)  The  income  of  the  partnership  is  the  amount 

stated  at  the  bottom  of  the  chart, 

(d)  The  individual  is  entitled  to  a personal 

exemption  of  $2, COO, 


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Chart  No.  2 


Business  Organization — Partnership 

Chart  showing  the  percent  of  the  income  received 
by  a partner  from  a given  partnership  that  is  taken 
by  the  normal  tax  and  surtax; 

Provided 

(a)  The  individual  is  entitled  to  ninety-eight  percent 
of  the  profits  of  the  partnership. 

(b)  The  income  of  the  individual  from  other  sources  is 
the  amount  indicated  at  the  right  end  of  each  line. 

(c)  The  income  of  the  partnership  is  the  amount  stated 
at  the  bottom  of  the  chart. 

(d)  The  individual  is  entitled  to  a personal  exemption 
of  $2,000. 


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Chart  No. 3 


Business  Organization- -Partner ship 
Chart  showing  the  percent  of  the  income  received  by  a 
partner  from  a given  partnership  that  is  taken  by  the  normal 
tax  and  surtax: 

Provided: 

(a)  1,  The  red  line  indicates  the  result  when  the  individual 

is  entitled  to  ninety-eight  percent  of  the  profits 
of  the  partnership, 

2.  The  green  line  :<ndicates  the  result  when  the 

individual  is  entitled  to  fifty  percent  of  the 
profits  of  the  partnership, 

3.  The  black  line  indics.tes  the  result  when  the  individual 

is  entitled  to  ten  percent  of  the  profits  of  the 
partnership. 

(b)  The  income  of  the  individual  from  other  sources  is  the 

amount  indicated  at  the  right  end  of  each  line. 

(c)  The  income  of  the  partnership  is  the  amount  stated  at 

the  bottom  of  the  chart, 

(d)  The  individual  is  entitled  to  a personal  exemption 

of  $2,000. 

Note: 

If  the  income  of  the  owners  of  the  partnership  from  otxier 
sources  is  $100,000  or  more  the  sharing  of  the  profits  does  not  affect 
the  rate  of  tax  so  long  as  the  total  income  of  any  one  is  not 
over  $150,000.  They  eCLl  pay  the  same  rate  of  tax. 


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Charts  No,  445 


Business  Organization — Corporation 

Chart  showing  the  percent  of  the  income  of  a corporation 
that  is  taken  by  the  corporation  income  and  excess  profits  taxes. 
Conditions  assumed j- 

(a)  The  invested  capital  of  the  corporation  is  the  amount 
indicated  at  the  right  end  of  each  line. 

(b)  The  taxable  profit  of  the  corporation  is  the  amount 
stated  at  the  bottom  of  the  chart. 

Notes: - 

(1)  Chart  No.  5 is  that  portion  of  chart  No.  4 which  is 
marked  off  by  the  dotted  line.  The  scale  in  chart  No,  5 
is  eight  times  as  large  as  that  in  chart  No. 4, 

(2)  On  an  income  of  $10,000  or  more  the  tax  is  the  same 
whether  the  invested  capital  is  $10,000,  $15,000,  $20,000, 

$25,000  or  $35,000. 

(3)  In  no  case  does  the  tax  amount  to  less  than  six  percent 
of  the  profit. 

(4)  For  an  invested  capital  of  $25,000  and  an  invested 
capital  of  $35,000  the  tax  is  identical  in  all  cases. 

{5)  If  the  invested  capital  is  $50,000  the  tax  is  the  same 
as  it  is  for  an  invested  capital  of  $25,000  except  when  the 
profit  is  $10,000. 

(6)  An  increase  in  the  invested  capital  does  not  affect  the 
rate  of  the  tax  when  the  taxable  profit  is  less  than  the 
excess  profits  credit. 

(7)  If  the  taxable  profit  of  the  corporation  is  large  enough 
to  meike  the  corporation  subject  to  the  excess  profits  tax  of 
forty  percent,  the  corporation  income  ana  excess  profits  taxes 
take  forty-six  percent  of  all  auditional  profit  earned  by  the 
corporation. 


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Chart  No.  6, 

Business  Organ! zat ion- - Corporation 
Chart  giving  a comparison  of  the  burden  laid  on  the  large 
stockholder  and  the  small  stockholder  of  a corporation  by  the 
corporation  income  and  excess-profits  taxes  and  the  surtax  paid 
by  the  individual. 

Conditions  assumed: - 

(a)  The  invested  capital  of  the  corporation  is  $25,000  or  $35,000. 

(b)  The  black  lines  indicate^  the  result  when  the  stockholder  owns 
ninety- eight  percent  of  the  stock. 

The  red  lines  indicate  the  result  when  the  stockholder  owns 
ten  percent  of  the  stock. 

(c)  All  the  earnings  remaining  after  the  corporation  income  and 
excess-profits  taxes  are  paid  are  distributed  as  dividends. 

(d)  The  income  of  the  stockholder  from  other  sources  is  the  amount 
indicated  at  the  right  end  of  each  line. 

(e)  The  income  of  the  partnership  is  the  amount  stated  at  the 
bottom  of  the  chart. 

(f)  The  individual  is  entitled  to  a personal  exemption  of  $2,000. 
Notes: - 

(1)  The  line  showing  the  lowest  rate  of  tax  indicates  the  percent 
paid  by  the  corporation  as  an  income  and  excess  profits  tax.  This 
line  practically  agrees  with  the  line  showing  the  tax  paid  by  a- 
stockholder  who  owns  ten  percent  of  the  stock  and  whose  income  from 
other  sources  is  $2,000. 

(2)  'JVhen  the  income  of  individual  is  $100,000  the  percent  taken 
wheii  the  stockholder  owns  ten  percent  of  the  stock  is  practically  the 
same  as  when  he  owns  ninety-eight  percent.  This  is  caused  by  the 
fact  that  the  surtax  of  fifty-two  percent  is  levied  on  all  incomes 
between  $100,000  and  $150,000. 

(3)  The  lines  show  a definite  variation  and  are  largely  influenced 
by  the  corporation  income  and  excess  profits  taxes. 


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Chart  No,  7 


Business  Organization — Corporation 

Chart  giving  a comparison  of  the  burden  laid  on 
the  large  stockholder  and  the  small  stockholder  of  a 
corporation  by  the  corporation  income  and  excess- 
profits  taxes  and  the  surtax  paid  by  the  individual. 
Conditions  assumed; - 

(a)  The  invested  capital  of  the  corporation  is  $100,000. 

(b)  All  the  other  conditions  are  the  seime  as  are  given 
for  chart  No.  6. 

Notes 


Notes  are  the  same  as  are  given  for  chart  No,  6. 


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“'“"Cliart'Kb.  8. 


Business  Organization 
Either  Corporation  or  Partnership. 

Results  shown  by  the  chart 

I,  The  effect  of  the  invested  capital  of  the  corporation  on  the  percent  of 
the  profits  belonging  to  the  individual  that  are  taken  by  the  corporation  in- 
come and  excess-profits  taxes  and  the  surtax  paid  by  the  individual. 

II.  The  burden  imposed  by  the  income  tax  on  the  stockholder  of  a corporation 
as  compared  with  the  burden  iuposed  on  the  member  of  a partnership. 

Conditions  assumed; - 

(a)  The  black  lines  indicate  the  result  for  a corporate  organization  with  an 

invested  capital  of  $25,  COO  or  $35,000. 

The  red  lines  indicate  the  result  for  a corporate  orgeinization  with  an 
invested  capital  of  $100,000. 

(b)  In  all  cases  the  individual  owns  ten  percent  of  the  stock  or  is  entitled 

to  ten  percent  of  the  profits  of  the  business. 

(c)  All  the  earnings  remaining  after  the  corporation  pays  its  income  and 

excess-profits  taxes  are  declared  as  dividends. 

(d)  The  green  lines  indicate  the  tax  if  the  business  is  organized  as  a 

partnership. 

(e)  The  income  of  the  stockholder  from  other  sources  is  the  amount  indicated 

at  the  right  end  of  each  line. 

(f)  The  income  of  the  business  is  the  amount  stated  at  the  bottom  of  the  chart, 

(g)  The  individual  is  entitled  to  a personal  exemption  of  $2,000. 

Notes:- 

(l)  The  two  lines  starting  at  six  percent  show  the  percent  paid  by  the  cor- 
poration as  an  income  and  excess  profits  tax.  If  no  dividend  is  declared  this 
is  the  percent  of  the  profits  belonging  to  the  stockholder  that  is  taken  by 
the  tax. 

(8)  The  tax  on  an  income  of  $5,000  is  the  same  for  both  corporations.  There- 
fore the  burden  on  the  stockholders  of  both  corporations  is  the  same. 

(3)  The  difference  between  the  burden  on  the  stockholders  in  the  two  corpora- 
tions is  caused  entirely  by  the  difference  in  the  corporation  income  and  excess- 

profits  taxes  and  this  in  turn  is  caused  by  the  amount  of  the  invested  capital. 


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Chart  No.  9, 


Business  Organization 
Either  Corporation  or  Partnership 
Results  shown  by  the  chart; 

I.  The  effect  of  the  invested  capital  of  the  corporation 
on  the  percent  of  the  profits  belonging  to  the  individual 
that  are  taken  by  the  corporation  income  and  excess-profits 
taxes  and  the  surtax  paid  by  the  individual. 

II.  The  burden  imposed  by  the  income  tax  on  the  stockholder 
of  a corporation  as  corq>ared  with  the  burden  imposed  on  the 
member  of  a partnership. 

Conditions  assumed: 

(a)  In  all  cases  the  individual  owns  ninety-eight  percent 

of  the  stock  of  the  corporation  or  is  entitled  to 
ninety-eight  percent  of  the  profits  of  the 
partnership. 

(b)  All  the  other  conditions  are  the  same  as  are  given  for 

chart  No.  8, 

Notes; 

The  notes  are  the  same  as  are  given  for  chart  No.  8. 


Chart  No.  lo. 


Business  Organization 
Either  Corporation  or  Partnership, 

Results  showi  by  the  chart 

I.  The  effect  of  dividends  on  the  percent  of  profits  belonging  to  a stock- 
holder that  is  taken  by  the  corporation  income  and  excess-profits  taxes  and 
the  surtax  paid  by  the  individual, 

II.  The  burden  imposed  by  the  income  tax  on  the  stockholder  of  a corporation 
as  compared  Tdth  the  burden  imposed  on  the  member  of  a partnership. 

Conditions  assumed:- 

(a^  The  invested  capital  of  the  corporation  is  either  $25,000  or  $35,000. 

(b)  In  all  cases  the  individual  ov/ns  ten  percent  of  the  stock  or  is  entitled 

to  ten  percent  of  the  profits  of  the  business. 

(c)  1.  The  black  lines  indicate  the  result  when  all  the  earnings  remaining 

after  the  corporation  pays  its  income  and  excess  profits  taxes  are 
declared  as  dividends. 

2.  The  red  lines  indicate  the  result  when  twenty-five  percent  of  the 
earnings  remaining  after  the  corporation  pays  its  income  and  excess 
profits  taxes  are  declared  as  dividends, 

(d)  The  green  lines  indicate  the  tax  if  the  business  is  organized  as  a 

partnership. 

(o)  The  income  of  the  stockholder  from  other  sources  is  the  amount  indicated 
at  the  right  end  of  each  line, 

(f)  The  income  of  the  business  is  the  amount  stated  at  the  bottom  of  the 

chart . 

(g)  The  individual  is  entitled  to  a personal  exemption  of  $2,000. 

Notes:  - 

Ci;  The  black  line  showing  the  lowest  rate^gives  the  percent  paid  by  the 
corporation  as  an  income  and  excess  profits  tax.  If  no  dividend  is  de- 
clared this  is  the  percent  of  the  profits  belonging  to  the  stockholder 
that  is  taken  by  the  tax, 

(2)  If  only  twenty-five  percent  of  the  earnings  are  paid  as  dividends 
and  the  stockholder  has  other  income  of  $2,000  the  stockholder  is  not 
subject  to  the  surtax  and  the  lowest  black  line  also  gives  the  rate  of 
the  tax  on  his  share  of  the  corporation  income. 

(3)  If  all  of  the  income  of  the  corporation  is  declared  as  dividends  the  rate 
of  the  tax  on  the  income  of  the  man  who  has  other  income  of  $2,000  varies  but 
little  from  the  rate  paid  by  the  corporation. 


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wtmt  • — - 


Chart  No.  11 


Business  Organization 
Either  Corporation  or  Partnership 
Results  showi  by  the  chart 

I.  The  effect  of  dividends  on  the  percent  of  profits  belonging 
to  a stockholder  that  is  taken  by  the  corporation  income  and 
excess-profits  taxes  and  the  surtax  paid  by  the  individual. 

II.  The  burden  imposed  by  the  income  tax  on  the  stockholder  of 
a cojTporation  as  compared  with  the  burden  imposed  on  the  member 
of  a partnership. 

Conditions  assumed 

(a)  In  all  cases  the  individual  owns  ninety- eight  percent  of  the 
stock  or  is  entitled  to  ninety-eight  percent  of  the  profits  of  the 
business. 

(b)  All  the  other  conditions  are  the  same  as  those  given  for 
chart  No.  10. 

Notes :- 

(1)  The  black  line  showing  the  lowest  rate  of  teuc  gives  the  percent 
paid  by  the  corporation  as  an  income  and  excess  profits  tax.  If  no 
dividend  is  declared  this  is  the  percent  of  the  profits  belonging 

to  the  stockholder  that  is  taken  by  the  tax. 

(2)  If  only  twenty- five  percent  of  the  income  of  the  corporation 
is  declared  as  dividends  and  the  stockholder  has  other  income  of 
$2,000  the  line  showing  the  percent  taken  very  nearly  agrees  with 
the  line  showing  the  percent  paid  by  the  corporation. 


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.■  - u:  .• 


Business  Organization 
Either  Corporation  or  Partnership, 

Results  shown  by  the  chart 

I.  The  effect  of  dividends  on  the  percent  of  profits  belonging 
to  a stockholder  that  is  taken  by  the  corporation  income  and 
excess-profits  taxes  and  the  surtax  paid  by  the  individual, 

II,  The  burden  imposed  by  the  income  tax  on  the  stockholder 
of  a corporation  as  compared  with  the  burden  imposed  on  the 
member  of  a partnership. 

Conditions  assumed;- 

(a)  The  invested  capital  of  the  corporation  is  $100,000. 

(b)  All  the  other  conditions  are  the  same  as  those  given 

chart  No,  10. 

Notes: — 

The  notes  for  this  chart  are  the  same  as  for  chart  No,  10, 


1 


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Chart  No.  13. 


Business  Organization 
Either  Corporation  or  Partnership 
Results  shown  by  the  chart 

I,  The  effect  of  dividends  on  the  percent  of  profits  belonging 
to  a stockholder  that  is  taken  by  the  corporation  income  and 
excess-profits  taxes  and  the  surtax  paid  by  the  individual, 

II.  The  burden  imposed  by  the  income  tax  on  the  stockholder  of 
a corporation  as  compared  with  the  burden  imposed  on  the  member 
of  a partnership. 

Conditions  assumed 

(a)  The  invested  capital  of  the  corporation  is  $1CC,C00 

(b)  In  all  cases  the  individual  owns  ninety-eight  percent  of 

the  stock  or  is  entitled  to  ninety-eight  percent  of  the 
profits  of  the  business. 

^c)  All  other  conditions  are  the  same  as  those  given  for  chart  No.  10. 
Notes — 

The  notes  for  this  chart  are  the  same  as  for  Chart  No,  11, 


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Chart  No.  14 


Business  Organization 
Either  Corporation  or  Partnership 
Chart  shovTing  a comparison  of  the  burden  itaposed  by  the  Income 
tax  on  the  stockholder  of  a corporation  as  compared  vvith  the 
burden  imposed  on  the  member  of  a partnership. 

Conditions  assumed 

(a)  The  black  lines  indicate  the  percent  of  the  income  of 

corporations  of  various  sizes  that  is  taken  by  the 
corporation  income  and  excess“profits  taxes. 

(b)  The  black  lines  also  show  the  percent  of  the  income  of 

the  stockholder  that  is  taken  by  the  tax  when  no  dividends 
are  declared  by  the  corporation.  The  results  are  the  same 
regardless  of  the  nwnber  of  shares  owned. 

(c)  Share  of  partnership  owned: 

(1)  The  solid  red  lines  indicate  the  percent  taken  by  the tax 

when  the  partner  is  entitled  to  ninety- eight  percent 
of  the  profits  of  the  partnership. 

(2)  The  broken  red  lines  indicate  the  percent  taken  by  the 

tax  when  the  partner  is  entitled  to  fifty  percent  of 
the  profits  of  the  partnership. 

(3)  The  green  lines  indicate  the  percent  taken  by  the  tax 

when  the  partner  is  entitled  to  ten  percent  of  the 
profits  of  the  partnership, 

(d)  The  income  of  the  individual  from  other  sources  is  the  amount 

indicated  at  the  right  end  of  each  line. 

(e)  The  income  of  the  business  is  the  amount  stated  at  the  bottom 

of  the  chart. 


(f)  The  individual  is  entitled  to  a personal  exeraption  of  |2,.000 


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ACKNOWLEDGMEtTT 


The  writer  wishes  to  express  his  gratitude  for 
the  kindly  aid  and  helpful  suggestions  of 
Professor  H.  T.  Scovill  under  whose  supervision 
this  paper  was  prepared. 


¥: 

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f.  -t.  >> . 


